The rally in perspective

There’s an excellent piece from the Wall Street Journal today looking at the sustainability of the current rally.  It’s not an argument that stocks from different sectors have tremendously benefitted from the positive earnings of the second quarter and to some degree Q1 as well.  More than 70% of stocks in the S&P 500 index have beaten expectations yet many have done so mainly through cost cuts.  And companies can only cut so much cost.

In the short-term, earnings prospects may remain favorable for the market. Aggressive expense control and modest inventory restocking could boost third-quarter numbers, while the fourth quarter has easy comparisons against an awful 2008 that will give the appearance of healthy profit increases. But in 2010, the ability of stocks to sustain or extend their advances will have to come from a revival in sales, strategists say. In an uncertain economic environment, that won’t be an easy task.

“You can not simply cut costs forever to have sustainable earnings. You need revenues to grow them over time,” says Dirk Van Dijk, chief equity strategist at Zacks Investment Research. However, “it’s going to be really, really tough” to increase revenue in the current economy, he says.

Source: WSJ.

The same piece shared a chart showing the sharp decline in selling, general and administrative expenses – which include salaries (used to be) paid to (now offloaded) workers.

WSJ-SGAEx

If US consumers cannot help the businesses recover quickly from the slump, the emerging markets might just run to the companies’ rescue.  And that is not even limited to the BRIC countries.  You have Asian economies whose economies have already exited the recessionary phase and are now positioned to increase their spending (some are not even in recession; growth has just slowed).  Maybe the market’s rally can extend further to year-end as some suggest, but there’s just no way it can continue the run up unless it sees some correction and investors once again see growth on the top line.

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